Distractions can be both good and bad, hence the term a “welcomed distraction.” And the past 11 months have brought a plethora of distractions, particularly for those working from home with kids. As I write, I can hear someone wailing about how it’s not fair his younger brother gets to play videogames while he must read. Sorry, I got distracted. Where was I? Yes, distractions.
Our more digitally-connected world creates even more distractions. We surround ourselves with technology and platforms that primarily disrupt our flow of consciousness. Whether it is team chats on “workplace productivity” platforms, group texts with friends who don’t know a put from a call, or doom-scrolling on Twitter to see the latest hot take on the topic du jour, we tell ourselves, ”This is how I can stay connected to the world.” But most of what we engage in is repetitive banter, not the type of welcomed distraction that can reset the brain.
The non-stop GameStop (GME) fascination last week was the latest distraction we had to endure, taking the championship distraction belt away from the Bernie Sanders inauguration meme. While there are some legitimate market structure questions emanating from the GameStop/Reddit event, the mindshare it garnered obfuscated the real issues/trends facing our socioeconomic environment.
While 559 million shares of GME traded over the past week,1 4 million people were diagnosed with COVID-19, 100,000 died,2 variants originating in South Africa and the UK were found in the US,3 two more vaccines may now be available by March, 31 million people got vaccinated,4 it was revealed the US economy grew by 4.2% versus an estimated 4%,5 hopes for an immediate $1.9 trillion stimulus were dashed,6 and $3 trillion of market capitalization was wiped off the global equity markets.7
Understanding those trends and how they will impact the market, the economy, and our day-to-day lives is far more important than if someone has paper or diamond hands8 when it comes to how they trade a retail videogame shop. Yet the distractions will continue, as our society is now accustomed to the 30-second soundbite rather than the 30-page analysis that would offer more detail and lasting insight.
Blocking out unnecessary distractions is going to be important no matter what happens next. Focusing on what matters and structuring portfolios to navigate a market that over the next 12 months will continue to be fundamentally challenged by a confluence of macro risks – none of which are related to the last week of January – will be crucial to climbing out of the worst crisis in a generation. Overall, the recovery will continue to have its ups and downs, and investors should be aware of how cyclical assets may benefit if an effective vaccination program spurs broad-based growth and the stimulus continues to work its way through the real economy.
Cyclicals in focus
Even with markets declining, positioning continues to indicate a cyclical view from investors – signaling a bit more long-termism and macro focus than the gamification GameStop fueled headlines would lead you to believe.
Flows into cyclical, expansionary US sector exposures were positive once again this month and continue the trend they have been on since the dual headwinds of the vaccine timeline and election uncertainty were removed. Financials had $5.8 billion in inflows, followed by Energy’s $1.3 billion and roughly $1 billion each in Materials and Industrials.
Whether viewing flows under a traditional style or more specific factor-based lens, equity flows continue to point toward a cyclical bias. Traditional US small-cap and value funds garnered $5 billion apiece, the inverse of the trend for US large/broad market (-$12 billion) and growth ETFs (-$5 billion).
This is despite net outflows from US equity funds. Those flows, however, were mainly driven by a few sizable large-cap ETFs. While motivations here can be partly seasonal (January flows tend to be weaker due to the reversal of tax loss harvesting positions put on in the prior calendar year), flows also are tied to large institutional investors reducing leverage/exposure amid a pickup in volatility. Another motivation may be due to rotation toward overseas exposures as non-US focused equity ETFs took in $18.7 billion – their largest flow total since January of 2018. The interest overseas is based on more constructive valuations than in the US, stronger growth prospects (particularly in EM), and the hope for improving geopolitical/trade relationships as a result of the new US administration.
Some defense sought But it was not all risk-on as the need for defense amid a confluence of macro risks remained. Defensive core-aggregate exposures equated to 68% of $19 billion of bond ETF inflows. A percentage that increases after accounting for the $2 billion of inflows into the core-sector of Mortgage-Backed strategies. Despite those flows, cyclicality can be found in bond flow trends as well. Inflation-protected strategies took in $3.5 billion and credit related strategies were in net inflows on the month – led by Bank Loan funds amassing a monthly record of $1.7 billion.
Planning for a recovery The long-termism tinge to January flows is reinforced by the record assets gathered by Thematic ETFs. The funds focused on the future of our society took in $17 billion, following a record-setting annual figure in 2020 of $42 billion.
Overall, cyclicals are in favor right now as the plan is to recover, and the foundations for a return normalcy have been laid (stimulus, vaccines). The chart of the month depicts this shift toward cyclical equity exposures. Despite this view, there will be bumps in the road to recovery– one of the reasons we continue to see strong flows into defensive fixed income markets.
1 Bloomberg Finance L.P. as of February 1, 2021 based on volume from 1/25 to 1/29 2 Bloomberg Finance L.P. as of February 1, 2021 based on global data 3 "Variants Spreading in US Fan the Need to 'Crush' Covid Quickly", Bloomberg Feburary 1, 2021 4 Bloomberg Finance L.P. as of February 1, 2021 based on global data 5 "US Economic Growth Moderated to 4% in Final Quarter of 2020", Bloomberg January 28, 2021 6 "GOP Senators Offer $600 Billion Compromise", Bloomberg January 31, 2021 7 Based on the market capitalization of the MSCI ACWI IMI as of January 31, 2021 per Bloomberg Finance L.P. data
S&P 500 Index: A market-capitalization-weighted stock market index that measures the stock performance of the 500 largest publicly traded companies in the United States. MSCI ACWI Index: MSCI ACWI Index is a market capitalization-weighted index designed to provide a broad measure of equity market performance throughout the world. Bloomberg Barcalys US Aggregate Bond Index: The Bloomberg Barclays US Aggregate Bond Index measures the investment-grade, fixed-rate taxable bond market. Bloomberg Barcalys US High Yield Corporate Bond Index: Measures the below investment-grade, fixed-rate taxable bond market. MSCI USA Minimum Volatility Index: Designed to reflect the performance of a minimum variance (or managed volatility) equity strategy. Each index is calculated by optimizing a traditional cap weighted ''parent MSCI index'' to attain the lowest level of volatility for a set of constraints. S&P/LSTA Leveraged Loan 100 Index: The S&P/LSTA U.S. Leveraged Loan 100 Index is designed to reflect the performance of the largest facilities in the leveraged loan market. Growth: Characterized by higher price levels relative to fundamentals, such as earnings. Value: Characterized by lower price levels relative to fundamentals, such as earnings. Quality: Characterized by stable earnings, high return-on-equity and low debt. Low Volatility: Characterized by low levels of standard deviations or low beta. Smart Beta: A term for rules-based investment strategies that don’t use conventional market-cap weightings. RSI: The relative strength index (RSI) is a momentum indicator used in technical analysis that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset.
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